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Why Oil and Gas in the South China Sea Won’t Be Developed

The South China Sea has enormous potential for oil and gas reserves but territorial conflict will likely hold it back for years to come.

On July 16, the China National Petroleum Corporation (CNPC) decided to remove its oil rig from contested waters, stating that its exploration mission was completed after finding “sings of oil and gas.”

While moving the rig out of waters claimed by both China and Vietnam could cool tensions, the intractable dispute over territory is holding back what could be massive investment in oil and gas exploration.

The Wall Street Journal reported on several major international oil companies that are steering clear of the South China Sea because of the conflict, despite the potentially huge reserves of oil and gas in its waters.

Back in 2006, Chevron (NYSE: CVX) signed a deal with Petronas, Malaysia’s state-owned oil company, to conduct exploration in disputed waters east of Vietnam. After China sent a stern warning that doing so would violate China’s sovereignty, Vietnam offered naval protection to Chevron. Despite assurances from Vietnam, in 2007 Chevron closed the door on its operations there, citing the ongoing territorial dispute.

Chevron continues to work in the area, but is staying within Vietnam’s undisputed territory.

Harvest Natural Resources Inc. (NYSE: HNR), a Houston-based oil and gas company, has secured rights from China to drill in the South China Sea. The only problem is that their block was also separately awarded by Vietnam to another company. The clash was enough to scare away the company – Harvest’s CEO James Edmiston said in June that his company was currently divesting from assets in China.

At the same time, some companies are braving the risk. ExxonMobil (NYSE: XOM) has already worked with PetroVietnam in the South China Sea, drilling two wells in 2011 and 2012, and a third expected this year.

Canadian company Talisman Energy (TSE: TLM) also expects to drill two exploratory wells in disputed waters this year. The company’s vice president for Asia-Pacific operations, Paul Ferneyhough, thinks the risk is worth the reward. “I would describe these as world-class exploration blocks,” he told The Wall Street Journal.

The U.S. Energy Information Administration estimates that the South China Sea holds 11 billion barrels of oil and 190 trillion cubic feet of natural gas. Malaysia likely holds the most oil, with an estimated 5 billion barrels in its waters; Vietnam has 3 billion barrels; Brunei has 1.5 billion barrels; and China 1.3 billion barrels.

On the other hand, the dispute over territory seems to have been blown out of proportion. Much of those oil and gas reserves are located within uncontested territory close to the various countries’ shorelines.

The disputed territory, around the Spratly and Paracel islands, has a smaller upside. The EIA doubts the Paracel Islands – where CNPC’s controversial rig was exploring – holds important reserves of oil and gas. “Geologic evidence suggests the area does not have significant potential in terms of conventional hydrocarbons,” the agency said in a report on the South China Sea. CNPC announced that it found “signs of oil and gas,” but without estimates on reserves, the statement was not exactly a ringing endorsement. The problem is that geologic data is imprecise, so for now no one knows what lies beneath the seabed.

Nevertheless, the conflict will likely continue. CNPC may have removed its oil rig from contested waters, but Vietnam only sees malice in China’s decisions. “China's South China Sea policy is aggressive, so the withdrawal of the oil rig is only a tactic, a responsive measure they need to take right now,” said Tran Cong Truc, the former head of Vietnam’s border committee.

For China’s part, the strong nationalist feeling amongst its population could make it difficult for the Chinese government to ratchet down tensions. After the decision by CNPC to move its rig out of disputed territory, commentary on China’s blogosphere erupted in outrage, questioning the courage of its leaders.

The dispute will prevent a better understanding of the resource base in contested areas, a critical prerequisite for actual oil and gas production. Whether or not there are vast reserves of oil and gas in the South China Sea, the conflict – which has escalated to the point of violence in 2014 – will scare away any development for the foreseeable future.

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